Long-term care can be extremely expensive for many clients, with costs that are potentially catastrophic to their financial well being. Accordingly, planners commonly recommend long-term care insurance to help manage the risk. Yet as long-term care insurance costs continue to rise, the insurance itself becomes increasingly difficult to afford, forcing clients to make trade-off decisions about which policy options to select, such as whether to buy a long-thin policy (long benefit duration with small daily benefits) or a short-fat policy (short benefit duration with larger daily benefits). Historically, clients who could afford to do so have leaned in the direction of long-thin policies with lifetime benefits, to address the ever-present fear of an extremely long duration health care event, even though the reality is that most claims only last a few years. More recently, though, the direction has shifted, due to everything from the rise of state partnership programs to the increasingly expensive cost of lifetime benefits. Are short-fat policies now the way to go for long-term care?

The inspiration for today's blog post is some of the recent difficulties in the long-term care insurance market, as the price of coverage continues to rise, more insurers leave the marketplace (most recently, Prudential, following the exit of MetLife just two years ago), and an increasing number of clients must face challenging decisions regarding policy trade-offs. Perhaps the primary and most fundamental decision trade-offs to make for a long-term care policy is regarding the amount of the daily benefit versus the duration of the benefit period. Classically, this comparison is often something to the effect of: Should I purchase a $200/day benefit for 3 years, or a $100/day benefit for 6 years? In both cases, the starting “pool” of money is the same: $200/day x 3 years x 365 days = $100/day x 6 years x 365 = $219,000. Although this comparison isn’t always quite identical in price, it’s often close, and it helps to illustrate the underlying question – how does the client weigh the trade-off between a longer benefit period with smaller daily benefits, versus a shorter benefit period with a larger daily benefit?

Some experts in the industry call this a comparison between “short-fat” and “long-thin” policies – in essence, is the policy short (benefit duration) or long, and is the daily benefit amount fat (large daily benefit) or thin (small daily benefit). So given the choice between the short-fat policy ($200/day for 3 years) or a long-thin policy ($100/day for 6 years), which direction should clients go?

To the extent that the cost between the two is about the same, the short-fat policy is increasingly the winning choice. The reasons for this are numerous, but most common include the following:

If the client's claims on a short-fat policy simply aren’t high enough to extract the full daily benefit amount, the client can always make claims more slowly and in effect treat it like a $100/day policy that will last for 6 years. In other words, if the client purchases a $200/day policy with a 3 year benefit period, but only make claims of $100/day, the benefit pool will still last for 6 years, since at the end of the day benefits continue until the benefits pool is exhausted (and it would take 6 years to exhaust a $219,000 benefit pool at only $100/day). Thus, a short-fat policy can always be used as though it were a long-thin policy. However, if the client purchases it the other way around, and buy a long-thin policy, the client will have no such flexibility to accelerate the payments and treat it like a short-fat policy – once the client reaches the daily maximum of a long-thin policy, claims are capped and the client cannot receive any more benefits for that day (or week or month, depending on how benefits are calculated). Thus, a short-fat policy allows the client to maximize benefits with a higher cost of care, and still receive the equivalent benefits as a long-thin policy being claimed upon in smaller amounts due to a lower cost of care, while a long-thin policy simply restricts the ability to make claims in the case of more expensive care needs.

Although we often fear the ultra-long-term insurance claim (or the costs of a very extended period of long-term care needs if coverage is insufficient or non-existent), the reality is that the average need for care is only about 2-3 years (depending on which statistics are cited). So while it’s nice to be insured for a longer claim – if it happens – clients may be giving up a lot of benefits for the much-more-common, shorter-term claim where coverage can provide an immediate positive financial impact. And as the cost of long-term care insurance rises in the current environment, buying ultra-long term benefit periods - especially lifetime benefits - can be extremely expensive for some clients, even while the true need is highly improbable for most.

For those of limited means, where a significant long-term care event may ultimately cause the client to rely on Medicaid anyway, having a short-fat policy can at least provide substantive care and significant benefits for a limited period of time. If the individual outlives the time period and exhausts both their policy benefits and their assets, they may ultimately end out receiving support from Medicaid. However, with a long-thin policy, the individual may in fact require Medicaid sooner, because the long-thin policy cannot sustain private long-term care facilities at all if other assets are unavailable. At least with a short-fat policy, a full claim on the policy may fully cover the costs of care for a limited period of years before ultimately reverting back to an asset spend-down and Medicaid support (depending on the amount of the daily benefit, of course). And in the meantime, the assets have more time to grow before being used for care.

Another benefit of short-fat policies is the increased flexibility in choosing a facility. With a short-fat policy, the client will have the buying power, for a limited number of years at least, to choose from a broader range of facilities given the size of the daily amount available to pay for care (and when including any other available assets to pay for care). On the other hand, the long-thin policy – combined with the individual’s other assets – may be insufficient to afford a higher level of care at any point or for any reasonable amount of time. The short-fat policyholder in essence is buying additional flexibility with respect to care facilities – at least until the policy benefits are exhausted.

With respect to Medicaid planning, if the client was ultimately going to require Medicaid because both assets and benefits would eventually be insufficient to pay for care, it will likely apply whether the policy is long-thin or short-fat. Thus, given limited benefits to utilize before applying Medicaid, the short-fat policyholder receives full flexibility using the full daily benefit, and then relies on depleting assets before applying to Medicaid. However, it's notable that with partnership programs in an increasing number of states, much of the remaining assets for middle income families may be sheltered after exhausting a short-fat policy, avoiding the full spend-down Medicaid requirements. The long-thin policyholder, on the other hand, begins utilizing assets immediately in conjunction with the thin policy benefits to receive some care, and may ultimately deplete the assets even while still drawing claims on the policy. If after several years other assets are depleted, the long-thin policy insured may be forced to apply for Medicaid, even while continuing to receive the remainder of a $100/day benefit – however, whether that remaining claim is available or not, the individual will likely still be fully subjected to the rules of Medicaid at that point, which brings the value of those “extra” years of long-thin claims into some doubt.

In short (no pun intended), the short-fat policy gives the individual an “opportunity” to at least attempt to extract significant value from a long-term care insurance policy, and have more flexibility with respect to decisions about where and how care is received, even if the claim is only for a limited period of time. However, with a long-thin policy, the client typically only has the opportunity to harvest significant value from the policy if the claims really do last for an extended (and significantly less likely) period of time. And in the meantime, the long-thin policyholder may not have as much control over his/her choice of facilities for as long, especially if the other remaining assets available for care are quite limited.

The reality, though, is that this trade-off has one other factor to consider – that companies do tend to price a short-fat policy slightly higher than a long-thin policy that produces an equivalent-sized benefit pool. This is true for the exact reasons stated above – that a short-fat policy gives the insured a better chance, “on average,” to extract a significant claim on the benefit pool, compared to the long-thin policy insured that will only draw significant claims if the health event does in fact extend for a much longer (and unlikely) period of time. The company will generally price the policy accordingly. On the other hand, a short-fat policy for a fairly long benefit duration period might still be cheaper than an ultra-long lifetime benefit policy; in other words, if the long-thin policy that's being given up is a lifetime-long duration, the short-fat policy alternative might be surprisingly comprehensive and not necessarily all thatshort.

Nonetheless, when considering the trade-offs in short-fat versus long-thin policies, even with a slight cost difference, the short-fat policy virtually always prevails in the current environment, because of its superior opportunity to harvest value, and the insured’s often-significantly-improved flexibility with respect to their decisions about where/how to receive care for a limited time period.

So what do you think? Where do you weigh in on the decision between short-fat versus long-thin policies? Have you discussed long-term care insurance in this manner with your clients? Do you think clients focus too much on the risk of an ultra-long duration care event, or not enough? Do you see different decisions from clients depending on their overall wealth?

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Great analysis. The other thing I would add to this, is that if one were to use a short-fat policy, they could afford a nicer, or more appropriate facility (which was part of your analysis). However, in many cases, once the benefits and personal assets have been exhausted, and the client goes on Medicaid, facilities generally cannot “kick them out”, but rather must convert them to Medicaid patients for the duration.

Whereas, if they could not afford the high facility fees to begin with (because they opted for the thin policy), then they would end up in a lower-end facility – and certainly not be able to get in under Medicaid (you can refuse a patient, but can’t kick them out).

I am not sure the long-term care laws are the same in every state, but it certainly applies in many states.

I hope that makes sense.

http://www.AppleTreeWealthManagement.com Joseph Perrotta

Great post, as always.

I’ve analyzed this in the past, and it really seems to be a no brainer in favor of short-fat policies.

Even if there is a small added cost, the flexibility makes it well worth it. There if you need it, with the ability to extend the payment period of you don’t.

I’ve also seen a few hybrid products that meet this need, providing LTC insurance with relatively high daily limits if needed, and if not paying the DB at some point in the future.

This comes at an added cost, but again for the added flexibility it is appropriate for some clients.

Thanks again!

http://www.DuncanFinancialPlanning.com William Duncan

Hi Michael,
Short and fat wins with me. I do like a shared care rider for added protection against longer term claims. When there are budgetary concerns I look for tradeoffs, I’d rather go with a longer elimination period because I want the clients protected against long-term catastrophic events.

Great blog – Thanks!

http://www.completelongtermcare.com merian

there’s no one-size-fits-all when it comes to insurance. it really depends on a number of factors, and it depends on the individual